Bitcoin: Cheat Sheet

The digital currency doesn't glitter but it's like gold...

The digital currency doesn't glitter but it's like gold...

Bitcoin eh? Is this one of those virtual currencies, like World of Warcraft Gold?
Close but no cigar. Bitcoin is a so-called cryptocurrency - it's digital, like World of Warcraft Gold. However, unlike Warcraft Gold, it's not tied to any particular product or service.

And, like a traditional currency, Bitcoin can be used to buy, sell and make payments online and even in bricks-and-mortar shops.

Sure, spare Warcraft Gold can be sold to other gamers in exchange for real money but you're less likely to be able to find a non-Warcraft-related company that will let you pay them in Warcraft Gold. Not so with Bitcoin.

Bitcoin: Explained

Not an actual Bitcoin: Bitcoin is like cash but these aren't the kind of coins you can hold in your handPhoto: TraderTim

So Bitcoin is a new currency then?
Yes - a new currency with its own set of unique rules. Bitcoin describes itself as "the first decentralised digital currency". It's digital because the currency exists purely in electronic form. Bitcoins - or BTCs for short - are essentially mathematical tokens stored in a virtual wallet.

It's decentralised because there is no one central authority controlling the currency - there's no Central Bank of Bitcoin deciding when to issue more BTCs, for example. There are equally no banks or clearing houses in charge of Bitcoin payments. Bitcoin is a peer-to-peer network and cuts out the middleman entirely.

Bitcoin also differs from currencies such as the dollar in that there will only ever be a fixed number of Bitcoins created - a limit set at just under 21 million BTCs.

This ceiling means a fiscal process such as quantitative easing - where a government effectively prints money in an effort to stimulate the national economy - is not possible in the Bitcoin economy.

Consequently, the value of Bitcoin cannot be manipulated by a central entity, which makes Bitcoin more like real world gold. Just as there is only a finite amount of the shiny metal deposited in the ground, there is only a finite amount of Bitcoins to be mined.

Hang on a minute, what's with this mining lark? How can you mine a digital currency?
Just keeping thinking of gold, which has to be mined from the earth.

Bitcoins, on the other hand, are generated once a 'block' of data has been 'mined' or processed. These blocks of data are the transactional data in the Bitcoin network.

Bitcoin miners effectively make computational resource available to the Bitcoin network, and this processing power is then used for verifying and proving Bitcoin transactions and maintaining the security of the Bitcoin network. A lucky few Bitcoin miners will get a block of BTCs in exchange for their mining work.

The current value of a block is 50 BTCs - although this quantity will...

...decrease by half roughly every four years until the 21 million limit is reached, after which no more BTCs can be created.

How can I start mining this digital gold then?
Bitcoin miners need to download a Bitcoin mining client to get started trying to earn Bitcoins.

When Bitcoin first began it was possible to mine BTCs with just your average CPU. These days, with so many Bitcoin miners all rushing for electronic gold, you'll need fancier hardware - of at least the GPU variety - which is why you can find high-end graphics processors selling on eBay with the suffix 'Bitcoin-ready'. But with so many dedicated Bitcoin mining rigs now set up there is not likely to be much profit in Bitcoin mining for the average PC user.

For those who do want to get involved, the mining clients are typically free to download, although there is obviously a cost involved in mining Bitcoins - the computational cost and the electricity required to crunch all this data.

Is Bitcoin mining the only way to get Bitcoins then?
No, you can buy Bitcoins off people who already own them, assuming they're willing to sell them to you. If you have marketable skills you could also exchange some services for Bitcoins via websites set up for such a purpose, while small amounts of Bitcoins can also be acquired from sites offering loyalty programmes that pay out in fractions of Bitcoins.

If you'd rather acquire large quantities of BTCs there are various Bitcoin exchanges where you can use your real-world currencies to buy them. Those already flush with BTCs can obviously sell them on these exchanges, cashing out of BTC and back into more traditional currencies.

Did you say small amounts of Bitcoins? Are there Bitcents then?
In effect, yes - and dimes and quarters and even smaller amounts of Bitcoins, although the names for the majority of these BTC fractions have not yet been settled. Bitcoins are currently divisible up to eight decimal places - so the smallest possible tradable amount is 0.00000001 of a Bitcoin. It's called a Satoshi, in honour of Bitcoin's founder, Satoshi Nakamoto.

Bitcoin fees are typically measured in fractions of a BTC.

You mentioned fees again...
So I did. While Bitcoin transactions don't have to carry fees, certain transactions can incur them.

An example of a transaction that might incur a fee today is if the block of Bitcoin data to be processed exceeds a certain size. Bitcoin users can also voluntarily pay fees as an incentive for their transactions to be processed - to speed up transaction time.

However, it might also be possible to find Bitcoin clients that will process your transaction without a fee, if you're willing to wait a bit for your transaction to be processed.

At present there is no single fee system for BTC transactions, though. It depends on how the clients processing your transactions have been configured.

With the fees system by no means set in stone, it's likely to...

...evolve over time. See this page for more on Bitcoin fees.

This all sounds well and good but what about security? How is Bitcoin secured? Can't these BTCs be counterfeited or transactions faked?
Bitcoin is not called a cryptocurrency for nothing. BTCs must be cryptographically signed every time they are transferred, with each Bitcoin user having both a public key and a unique private key as well as a Bitcoin address to sign all their transactions.

A record of every confirmed transaction is then contained in a master registry called the blockchain, which is collectively maintained by all computers using the Bitcoin network.

Only the single longest and fastest-growing blockchain will be accepted as the genuine article - the basic premise being that the power of the network outstrips the ability of any bad individuals or entities trying to fake coins or transactions, and thus rejects them as bogus.

Likewise, anybody seeking to accelerate the process of Bitcoin mining will see their faux Bitcoins rejected by the network as the worthless bits they actually are. By maintaining a public record of all transactions - and timestamping them so they form a sequential chain - the Bitcoin network basically stays ahead of attempts to duplicate payments or clone coins. For more on the bitcoin electronic P2P network, you can read Nakamoto's full whitepaper.

One security vulnerability in the Bitcoin universe is individual accounts: since Bitcoins are stored in digital wallets on individuals' PCs, they are potentially vulnerable to hackers. Earlier this year a Bitcoin user claimed to have had $500,000-worth of BTCs swiped from his wallet - which is enough to make anyone run screaming back to the nearest bank.

The Mt. Gox Bitcoin Exchange - which trades in BTCs and US dollars - also suffered a hack attack this summer. A compromised account was used to sell off a swathe of Bitcoins, which led to a massive drop in the value of the currency. The hacker then attempted to buy back the Bitcoins at the new, much cheaper price. Mt. Gox now offers its customers YubiKey two-factor authentication in an effort to secure accounts.

Bitcoin-related malware exists too. Bitcoin botnet miners have been identified which seek to use the power of infected PCs to mine for Bitcoins or launch DDoS attacks against competing Bitcoin miners.

Bitcoin also claims transactions can be made anonymously, in the same way that cash transactions can. Again, this makes Bitcoin unlike other electronic payment methods which leave an audit trail - although it's worth noting some security researchers question how anonymous Bitcoin can truly be. This has led Bitcoin to gain a reputation as a way to pay for illicit or illegal substances such as drugs. The question of whether Bitcoin itself is legal is a whole other can of worms which I won't get into here.

Sounds like the 'B' in Bitcoin stands for 'Beware' then.
You certainly need to take careful measures to ensure the security of your Bitcoins. There are some good tips on keeping your BTCs safe in this article.

All these security issues are to be expected, of course. After all, hackers follow the money and Bitcoin is, well, money.

Alright. So where can I spend these Bitcoins once I have acquired some? Which shops accept them?
Not very many bricks-and-mortar shops as yet, but a fair amount of online merchants will...

...lighten your digital BTC wallet if you're willing. There's a list of Bitcoin-friendly merchants here - with a range of services including web hosting, cloud storage, mobile app development and digital art, to name but a few.

In the real world there's a smattering of Bitcoin-friendly hotels, eateries and other outlets in Europe and further afield - but nothing yet in the UK, according to this map.

Can my business start accepting Bitcoins?
There's no reason why not if you're game, although how practical Bitcoin is for your business depends on the type of business you're in and how many Bitcoin customers you expect to get. There's some advice for small business owners wanting to accept Bitcoins here.

It's also possible to embed a Bitcoin address within a QR code. This is one way for a bricks-and-mortar retailer to simplify the Bitcoin transaction process by making it easier for a mobile customer to grab your Bitcoin address, which they'll need to send you payment in BTCs.

What about investment potential? You mentioned Bitcoin was attracting interest among investors.
That's right. Bitcoins do not have a fixed value - their value depends on whatever Bitcoin buyers and sellers agree to trade them for. At the time of writing, a BTC is worth around the £3.50 mark but in recent months it soared to more than £12.50 - little wonder investors have been jumping on the Bitcoin bandwagon.

Gold bullion

Like gold, the Bitcoin currency has a finite value which makes it attractive to investorsPhoto: Shutterstock

This finite value principle makes Bitcoin potentially attractive to investors, just as gold bullion is attractive. There has been much talk recently of Bitcoin's potential as an investment opportunity - more of that anon too.

If all the gold in the world was miraculously unearthed on the same day the global price of gold would plummet because there would suddenly be a massive glut of the shiny stuff. Of course, it's fantastically unlikely that would ever happen so the price of gold remains relatively stable - in fact, it tends to increase over time. With Bitcoin, it's essentially impossible for a glut of BTCs to be generated by Bitcoin users because of the Bitcoin mining process.

The Bitcoin network aims to create six blocks every hour - or about 300 BTCs at the current block quantity. This means BTCs are introduced into the network at a steady rate.

The projected end date for the creation of all Bitcoins is around 2140. For more on the controlled currency supply of Bitcoin see this page.

Bitcoin speculating is not for the faint-hearted though. If you bought Bitcoin at £12.50 a pop you're clearly not quids in at today's prices. And Bitcoin Watch, a Bitcoin market analyser, is projecting further falls in the price of Bitcoin over the mid to long term. In short, expect volatility.

Anything else?
The rush of investors to the Bitcoin market has led some commentators to suggest Bitcoin could become trapped in a deflationary spiral. This scenario occurs when the flow of currency is restricted - in this case by investors hoarding not spending their BTCs - causing prices to fall because people just can't get the coin to spend.

It's worth remembering despite the waves it's been making in the financial world that Bitcoin is still relatively new in currency terms - it only launched in 2009. Whether Bitcoin will end its days trapped in deflationary doom remains to be seen. It's far too early to predict how this bold experiment with digital gold will pan out.